Paul Scrivener explains why the Cayman Islands has come to be known as one of the world’s leading international financial centres
Whilst the Cayman Islands started its financial services industry on the strength of private banking business, in recent years the focus has been very much towards institutional business, a key factor in Cayman becoming one of the world’s leading international financial centres. Cayman vehicles are frequently utilised by large corporate groups and financial institutions to structure transactions in an efficient and cost-effective way by virtue of the tax neutral and proportionate regulatory environment available in the Cayman Islands. Whether those vehicles facilitate legitimate tax deferral on foreign source trading income, serve a treasury function, hold intangibles or enable an international joint venture, they provide true economic benefits for the shareholders and other stakeholders of those onshore groups and institutions.
The Cayman Islands is a recognised centre of excellence in three specific areas of institutional business: investment funds, structured finance and captive insurance. There are a number of features that have enabled the Cayman Islands to attract and retain business in these three areas. Some are obvious and are frequently spoken about – political and economic stability, a business-oriented government, a tried and tested legal regime and a regulatory framework which is robust and in accordance with international standards but not unnecessarily burdensome or cost prohibitive. Other features are more subtle, notably, the presence of a professional infrastructure of service providers with considerable international experience and expertise across a number of disciplines (Cayman Inc’s "intellectual capital") whose work ethic, commitment and business-like approach is just as strong as the best of their onshore counterparts. Much of this institutional business comes to the Cayman Islands because the absence of unnecessary regulation, the user friendly legal regime and the tried and tested nature of the transactions and structures, means that projects can be completed in much shorter timescales than would be possible onshore and at a significantly lower cost.
The Cayman Islands is a true heavyweight in the investment funds arena and has carved out a particular niche in respect of hedge funds and other alternative investment funds, with some 60% of the world’s offshore hedge funds being domiciled in the jurisdiction, a truly remarkable statistic. As at 30 June 2005 there were more than 6500 regulated investment funds in Cayman and it expected that this figure will reach 7000 by the end of the year since on average the Cayman Islands Monetary Authority are processing 35 fund applications each week.
Features such as a balanced regulatory framework which recognises that investors in hedge funds are highly sophisticated investors, the absence of unnecessary licensing provisions and significant flexibility with regard to investment objectives, risks, service providers and other commercial matters, create the perfect environment for fund managers specialising in alternative investments.
The United States remains the single most important source of business in this area but other regions of the world, particularly Europe and the Far East are of increasing importance and this is expected to continue. Frequently, it is the fund manager’s onshore legal counsel who will direct their client to the Cayman Islands as the domicile of choice and structuring flexibility – whether, stand-alone, master feeder, side by side, fund of funds or segregated portfolio company – is frequently an important factor.
Statistics are difficult to gather in the structured finance area because the vehicles involved are not regulated entities, but Cayman is generally acknowledged to be the largest offshore centre for structured debt transactions, whether that be simple euro paper issues, repackagings, aircraft or ship financing or the more complex securitisations of mortgages, credit card receivables, car loans, music royalties and the like.
Structured finance has been and remains an enormous growth area in the global financial services industry, providing issuers with cheaper and more efficient funding combined with greater balance sheet flexibility and investors with a broad selection of fixed income investment alternatives usually with a high credit rating and stable cash flows. This is combined with protection against the potential bankruptcy of the issuer.
The Cayman elements of any structured finance transaction will be the establishment of a bankruptcy remote vehicle which owns the assets the subject of the transaction and the provision of service providers to the entity (principally, the directors and the trust company which will own the shares in the entity) to ensure that the integrity of the structure is not tainted in any way. The integrity of the structure is of paramount importance. The vehicle must have its own mind and management and its own voice in the relevant transactions, hence the importance of experienced Cayman professional directors who have a high level of expertise in structured finance.
Many of the features that have contributed to the development of the funds business in the Cayman Islands equally apply to structured finance. In addition, the absence of withholding tax problems, exchange controls, a creditor friendly legal system (there is, for example, no formal corporate rehabilitation procedure akin to US Chapter 11) and the ability to readily obtain an investment grade rating, are particularly significant for structured finance. Challenges clearly lie ahead as a result of onshore developments post-Enron, but structured finance in the Cayman Islands remains in good health.
Cayman is also a leading domicile for captive insurance companies particularly for those writing hospital and medical malpractice coverage. Cayman came to the forefront as an offshore insurance domicile in the middle to late 1970s at a time when purchasers of liability insurance in North America, particularly hospitals and physicians, found it difficult to obtain professional liability cover at reasonable rates, if indeed it could be found at all. The lack of insurance available in the conventional market, coupled with spiraling premiums, caused many of them to form captive insurance or re-insurance companies. The Cayman Islands is now the world’s second largest domicile for captive insurance and by 30 June this year the total number of captives in the Cayman Islands stood at an impressive 709.
Many of the captives formed in the Cayman Islands are single parent captives established as a wholly owned subsidiary of an onshore parent formed primarily to insure the risks of that parent or its affiliates. Other common structures include association captives, a captive owned by a trade or industry association to share insurance risks among its members and group captives, where the captive is jointly owned by a number of companies and provides a vehicle to meet a common insurance need. Cayman is also home to rent-a-captives or segregated cell facilities, which are usually formed by insurance companies, brokers and captive managers and are structures that rent their surplus or capital to their clients and to segregated portfolio companies, whose particular characteristic is to legally segregate the assets and liabilities of each segregated portfolio or cell within the company, thereby ring-fencing the capital of each client.
What has led to Cayman’s success in captive insurance? One of the key factors is that there is a well-developed professional infrastructure with insurance managers that understand the market and can react quickly to their clients’ needs and who are supported by insurance expertise amongst the law firms and accounting firms in the Cayman Islands. In addition, the insurance legislation is modern and straightforward, the regulator is very accessible to prospective licensees and the licensing regime for captives is effective without being excessive in its requirements. Most captives can be established within two months.
Institutional business in the Cayman Islands is definitely thriving. The outlook for the short to medium term is very optimistic with Cayman ideally placed to continue to hold a significant share of the worldwide business in investment funds, structured finance and captive insurance and to retain and strengthen its position as one of the world’s leading international financial centres.
Paul Scrivener is a partner in Cayman Islands commercial law firm, Solomon Harris and was formerly a partner in the UK law firm, Eversheds. Paul heads up the investment funds group at Solomon Harris and also specialises in captive insurance.
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